Avoid Large Losses: Part II

Written by Dave Young, President of Paragon Wealth Management

 

photo by tatoodjj

It is constantly proclaimed in the media that we are experiencing the worst economy since the great depression. I agree that the economy is bad and the investment markets have been terrible. However, to compare this downturn with the great depression is like comparing the Vietnam War with World War II. Both were horrible wars, but when you look at the actual statistics, there is no comparison between the two.

In our booklet, Seven Steps for Building Wealth, the fifth step is "Avoid Large Losses". This post will discuss what that means for investors today, who are investing during this difficult time.

From January 1998 through May 2009 our primary portfolio, "Top Flight", generated a total return of 276% versus only 15% for the S&P 500. Investors often assume that since our returns are high our portfolios must take more risk than normal. Actually the opposite is true. Much of our excess return has been generated by avoiding large losses.

In the most recent market cycle, From January 1, 2007 to May 31, 2009 the S&P 500 lost 31.6% of its value. Most investors have done even worse because of their allocation and the cost associated with their investments. During that same period of time, our actively managed Top Flight portfolio is down only 14.9%.

We are never happy to have negative returns. Our objective is to minimize losses wherever possible.  This bear market has been more difficult for us than any of the previous ones.

To truly compare performance the most important question to ask is "How much of a return is needed by each investment strategy, in order to make back your money and get back to even?"

Calculating percentage returns is different than most investors realize. For example, if you have a 25% loss then you need 33% to get back to even, which is workable.  If you lose 50% of your portfolio, you have to make 100% to get back to even, obviously a much more difficult task.

I'll compare our flagship portfolio, Top Flight, to the S&P 500.  For Top Flight to get back to even and recover its 14.9% loss it only needs to earn 17.5%. For the S&P 500 to recover its 31.6% loss, it will need to earn 46.5% to get back to even. As you can see, the size of the loss has an exponential negative effect on an investor's ability to recover. It will take investors in the broad market (S&P 500) almost three times more effort just to get back to even.

Step number five, Avoid Large Losses, seems pretty straightforward and simple. Actually avoiding losses is much more difficult when investing real money. That is why it is so important that investors follow a disciplined, non-emotional, proven strategy if they hope to succeed over the long term.

Comments

[jim]

How has top flight done the past 12 months vs S&P 500?